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Calculated Risk posted a thought-provoking chart showing how single family mortgage delinquency rates have largely tracked changes in the U.S. unemployment rate since 2005, which we've excerpted (see above right). From that chart, it would appear that foreclosure activity in the U.S. is pretty closely tracking changes in the unemployment rate.

Whenever we see that kind of apparently close correlation, we go the extra mile and try to map out the relationship that would appear to exist between the two factors. We've presented our chart showing the correlation between the U.S. unemployment rate and the U.S. single-family mortgage 90-day delinquency rate to the left (larger version near the bottom of this post.) What's more, we've also created a tool for projecting the foreclosure rate from the U.S. unemployment rate based on the data as it's behaved since January 2004.

Running the numbers for an unemployment rate of 10%, we find that we might expect the single-family mortgage delinquency rate to increase to a level around 2.7% of all mortgages, based upon the correlation we observe in the data that appears to have existed since 2004.

Unemployment Rate Data

Input Data

Values

U.S. Unemployment Rate [%]

Single-Family 90-Day Mortgage Delinquencies

Calculated Results

Values

Delinquency Rate [% of all mortgages]

The problem is that correlation between the U.S. unemployment rate and the percentage of mortgage delinquencies would appear to be something new.

They found that, contrary to the pattern we observe today and to what people might reasonably expect, that there was no real correlation between changes in the rate of U.S. unemployment and the rate of mortgage foreclosures. The chart to the right graphically presents both rates, along with the 10-year Treasury yield for reference. [Note: We've previously featured a tool that predicts 30-year conventional mortgage rates given the 10-year U.S. Treasury yield.]

We believe the difference between how the relationship between how the rate of delinquencies and the rate of unemployment from the 1950s into the 1990s and from the 1990s to today may be attributed to changes in the mortgages themselves beginning in the 1990s. Primarily, what changed were the lending standards.

Throughout much of the late twentieth century, mortgage lenders required homebuyers to invest significant equity in their properties, requiring substantial down payments at the time of purchase. Often representing 20% of the market value of the homes being bought, this equity stake helped insulate the mortgage lenders from the employment status of the homebuyers.

Likewise, the homebuyers were in part insulated from having their home foreclosed upon during such periods of unemployment thanks to this margin of safety. They could draw upon their home equity, either through taking out home equity loans or by selling their homes, to avoid the fiscal calamity of foreclosure.

But, beginning in the 1990s, the systematic erosion of such lending standards also led to the elimination of this safety margin. As a result, the margin of safety for significant numbers of mortgages shrank, exposing both lender and borrower to an increased risk of foreclosure in the event the borrower became unemployed.

That's exactly what we're seeing play out today.

But we believe that will end, given that we see that the rate of mortgage delinquencies appears to already be slowing, even as the unemployment rate increases.

Running the numbers for higher levels of unemployment suggests that as the unemployment rate increases, the percentage of mortgage delinquencies will peak around 2.8%. Intuitively, we believe that makes sense since we would expect that as the substantial already number of foreclosed properties are sold to new buyers who are being held to higher lending standards, the loans represented by these properties will move from the numerator to the denominator in the calculation of the delinquency rate.

Consequently, we would anticipate that the apparent correlation we are currently observing between the U.S. unemployment rate and the delinquency rate of single-family mortgages will break down, even if unemployment rates continue to rise.

Data Sources

We obtained the monthly unemployment rate data for the U.S. from the BLS' Current Population Survey database. Meanwhile, we obtained the corresponding monthly single-family 90-day delinquency rate for all mortgages spanning January 2004 through May 2009 from the following Freddie Mac reports for the indicated years:

Welcome to the Saturday, June 27, 2009 edition of On the Moneyed Midways, the one place you can count on each week to bring you the best of what we found in the world of business and money-related blog carnivals!

Long-time readers will know that we don't have late editions of OMM. No-sir-ee! Instead, we have "special" editions of OMM!

Of course, our "special" editions are in no way really distinguishable from our "regular" editions, but it sure sounds a lot better than "late!"

But we're late enough as it is, so let's get onto the best posts we found in the week that was!..."

16-year old Bryce Harper may very well have big-league talent, but the Happy Rock argues he doesn't seem to have big-league brains. Of course, we're talking about baseball where the IQ requirements aren't the same as for football or basketball….

Everyone thinks that entrepreneurs are most often found in the young. Paul Kedrosky graphically presents the findings of a Kauffman Foundation study that confirms that entrepreneurism isn't really a young person's game….

Tax preparer Robert D. Flach really, really doesn't need to know what happened inside your IRA last year. Really. He explains what he really wants to know about your IRA in The Best Post of the Week, Anywhere!

Assuming something really wacky doesn't happen on 30 June 2009, we would expect the S&P 500 will turn in an average value for the month somewhere close to the range between 926 and 944.

That's not a bold statement, given that the current average for the month through 24 June 2009 stands at 927.16, but we do anticipate that most of the downward noisy volatility in stock prices associated with the quadruple witching expiration of options last week is largely over and that, absent any disruptive events, we should expect stock prices to slowly rise from their 900.21 closing value recorded on 24 June 2009.

Investors appear to be focused on the level of trailing year dividends per share that will apply for the end of 2009, or rather, the dividend futures data for the first quarter of 2010 (the dividend futures contract for 2009Q4 expires on 20 December 2009 - the dividend futures contract for 2010Q1 will be the one in effect when New Year's Eve rolls around.) The changes in the expected rate of growth of dividends per share at this time, multiplied by an amplification factor ranging between 7.0 and 9.0, continues to appear to be the primary signal driving overall changes in stock prices.

The base from which stock prices are being measured appears to be the average of the S&P 500's daily closing prices established for the month of June 2008, 1341.25.

The annualized rate of change of stock prices from May 2008 through May 2009 of -35.7%.

Have you ever wanted to test out an investing strategy using historic stock market data? Or maybe just wanted to find out how much a hypothetical investment in the S&P 500 made between January 1871 and May 2009 would be worth after adjusting for inflation? Both with and without reinvesting dividends over all that time?

All you need to do is to select the dates you want to run your hypothetical investment between and to enter the amount of money to invest either from the very beginning or to add each month (beginning with that first month you select) for the duration that your investment runs.

We'll determine how much your investment would be worth assuming the amounts invested are adjusted for inflation for each month the investment is active and accounting for the effects of either not reinvesting dividends along the way or fully reinvesting dividends. Our other main assumptions are that no commissions, fees or taxes are paid by our hypothetical investor from their investment. We'll also calculate the average annualized rate of return you would have earned if you had invested all the money you did from the very beginning!

And it all starts... now!

Investing Period Data

Description

Value

Beginning Date for Investment

Ending Date for Investment

Investment Data

Description

Value

Initial Amount to Invest*

Amount to Invest Consistently Each Month*

Inflation Adjusted Investment Values*

Calculated Results

Without Reinvesting Dividends

Fully Reinvesting Dividends

Total Amount Invested

Gain [+] or Loss [-]

Final Investment Value

Average Annual Rate of Return

* Investment values are adjusted for inflation to be current for the Ending Date.

Running some numbers for fun, we find that if you started with $0.00 and invested $100.00 each month beginning in January 2009, the $200 you would have invested before selling in March 2009, when the S&P 500 hit bottom, would have fallen in value to $186.62, an annualized loss of 34% if you had been reinvesting dividends.

On the other hand, if you had kept investing through May 2009, the $400 you put to work in the S&P 500 would have risen in value to be worth nearly $462, an annualized gain of 54%!

But for real fun, see how much $1000 invested in January 1871 would be worth in May 2009 - both with and without the effects of reinvesting dividends! We don't want to spoil the surprise, but there's a $7,741,392.08 difference!

Welcome to the blogosphere's toolchest! Here, unlike other blogs dedicated to analyzing current events, we create easy-to-use, simple tools to do the math related to them so you can get in on the action too! If you would like to learn more about these tools, or if you would like to contribute ideas to develop for this blog, please e-mail us at:

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